Today we’ll evaluate Topps Tiles Plc (LON:TPT) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Topps Tiles:
0.23 = UK£14m ÷ (UK£104m – UK£43m) (Based on the trailing twelve months to September 2018.)
Therefore, Topps Tiles has an ROCE of 23%.
Does Topps Tiles Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Topps Tiles’s ROCE is meaningfully higher than the 13% average in the Specialty Retail industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Topps Tiles’s ROCE is currently very good.
Topps Tiles’s current ROCE of 23% is lower than 3 years ago, when the company reported a 37% ROCE. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Topps Tiles’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Topps Tiles has total liabilities of UK£43m and total assets of UK£104m. As a result, its current liabilities are equal to approximately 41% of its total assets. Topps Tiles has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Topps Tiles’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Of course you might be able to find a better stock than Topps Tiles. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Topps Tiles better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.